Supplement – Here comes the Treacle

Dec 4, 2022

“The fly that sips treacle is lost in the sweets.” – John Gay, English poet and dramatist


2 more supplements before Christmas day……’s not too early any more! Unbelievably we are into December, and are facing that part of the year that becomes the “treacle”. Productivity at your professional services partners will fall. People are creaking in the industry under the pressure of a massive year, and will indeed finally be looking forward to “Christmas without Covid”. Can you believe that only one year ago many were concerned about the Omicron variant, and venues were still cancelling functions on willing attendees? Me neither, but they were (it certainly happened to me and also one of my businesses).


One more knees-up before the recession? Maybe. But that’s just another variant of treacle – without a significant trigger point, or black swan style event, this recession, aided by high inflation, will pass through the populace like Carbon Monoxide – invisible, silent, deadly, and only occasionally fatal in a well-ventilated area. It is more death – or perhaps just light injury – by a thousand cuts, than it is a “thing” that happens to you, me or anyone who loses their ass(ets) in the melee.


A view of incoming stress on assets – real time

I wanted to open this week by sharing some of the events that I’m seeing on the ground, to give readers a chance to apply some of this logic in their own businesses, and this will also serve as a mini-roundup of the past few years and the resulting events.


There’s probably half a dozen factors that help to set the scene for the below; a list will be helpful:


i) Covid stimulus going directly to businesses – fantastic for liquidity and trading (and some other activities that funds were diverted towards!) in 2020, not so great when they need paying back after a 12 month moratorium on payments/payments covered by the government. Many of these loans at the CBILS level are either double digit interest or on floating rates/tied to base rate


ii) Interest rates going up making refinancing and new credit difficult, more expensive, unaffordable or impossible. 


iii) Debt pressure almost disappearing in 2020 and for much of 2021 – moratoriums on repossessions, leading to “zombie” companies with no future sleepwalking towards their inevitable apocalypse.


iv) Inflated property asset prices which have gone up 25%+ on paper but now are on the way down – we are at least 2.5% off the top, likely September 2022 for the record books on this cycle, however it plays out


v) Taxation deferral schemes – pay your VAT late, after 12 months, in instalments, etc. One more can kicked down the road.


vi) Inflation – costs creeping up, or bulldozing forwards, when some businesses have failed to anticipate this or price things accordingly.


This is a fairly lethal melting pot – and it isn’t even a comprehensive list! However, in the past month and more so in the past week, I’ve started to see real world examples of all of this, and how it is interacting to create opportunities in the stressed/distressed business/property company/landlord space. Here’s a quick summary of some of the reality of converting these into actual deals at the moment, list number 2 for the week:


Is it easy to come by deals already? Not easy……if it was……everyone would do it!

i) Why do I buy property? Normally for the long term, on the basis of a combination of discount and value-add, capital growth, and yield manifesting itself in positive cashflow. The first part needs to go up at the moment (i.e. bigger discounts) to sustain the predicting failings in the second part over the next 24 months or so, and the third part is much harder to come by thanks to vastly inflated costs outpacing rental growth, even though rental growth is very strong – with the most inflated cost of all being mortgage interest costs. That makes deals harder to do before anywhere near the majority of the oncoming treacle has played out.


ii) Reality hasn’t sunk in yet. The media sensationalises so much, all of the time, that now they are reporting actual house price falls, people aren’t believing them just yet. Also – going from a white hot sellers’ market, to a red hot one, to a buyers’ market (near as dammit) within a few months is not something the industry is used to.


iii) It’s still too early after the peak in bond yields and swap rates this year to call this the top. The bonds have flattened out, but tested lower than the current 3.25% 5y Gilt/3.75% 5y SONIA swap, and been rebuffed/shown a lot of resistance at lower levels. The best proxy for 5y ltd company fixes based on that would be about 5.25% from deposit takers, 5.75% from package lenders, and 6.25%-6.75% for specialist rates. The market isn’t perfect so it doesn’t reprice all that quickly, although there is some 5.29% out there at the moment from the Mortgage Works if you can or do want to transact with them. Thus my prediction in our modelling for 5y fixed rates in 6 months time, thinking of momentum style models – 6.25% (conservative, I know, but it needs to be – especially after recent events). 


iv) Base rate pressures really have not kicked in yet. Those who don’t do monthly management accounts (what percentage of property owners will this be? 90%+ I’d imagine by number, and 66%+ of owned units, simply because the sector is so amateurish still) will have noticed the cashflow, or lack of increase in bank balances, or similar – but won’t really have translated all of this into real numbers just yet. There’s more to come on loans tied to base, the likely path is still 0.5% up this month on December 15th. Remember, it takes 6 months for reality to hit the markets when the base rate rises, and the period of effect is 6-24 months long. It isn’t instant.


v) Some companies have started to talk to accountants who may well refer them to administrators. They are, effectively, trading insolvent and the writing is on the wall. It is hard to get to these leads, but the best way is to follow up what should already be in your pipeline. It is written all over their balance sheets and accounts on companies house, although that information is lagging, of course – but the time bombs are there, if you can bring yourself to comb through them and know what you are looking at.


vi) Speed and certainty are back as truly important, given all of the above – the property traders are mega busy again, the phones are ringing, the leads are being generated, and 2023 looks bright from their perspective – compared to very tough trading conditions in 2020, 2021 and much of 2022.


You can certainly read i) in my second list above and understand why investment volume should go down more than any other volume next year, potentially, depending particularly on rates. Residential property however has, as so often, proven itself to be so much more robust than stock market investments, let alone other more “alternative” “investments” (no, not a crypto I-told-you-so situation). It still looks comparatively good, and the falling knife is by no means a certainty. Quantifying it, and when it all plays out, is the difficult part, of course. But if we are prevented from exit on new projects, on many we would have bought, or would have paid more for – the mathematics kicks in and keeps new investment volume down, meaning lower rental stock if landlords continue with their recent wave of selling for a whole variety of reasons (many of which are alluded to in the above).


Volumes to fall and happy times for traders

This is where the conclusion comes from that transaction volume should drop significantly, certainly compared to recent years. Zoopla is still forecasting 1 million transactions next year – however, I’d be closer to 900,000 as I see things today. Don’t forget the transactions that came forward because of stamp duty breaks, and also the motivation to move because of Covid factors that meant an intergenerational change. Don’t also forget how few first time buyers might be able to move because of higher mortgage rates and the ability to save deposits being eroded by inflation, and wage rises below the cost of living. Rent looked expensive compared to mortgages – increasingly so – and that has changed massively in the past few months. Nearly 1.5 million transactions in 2021 was the busiest year since 2007…..and a massive outlier to a market that in normal times does around 1.2 million transactions based on the average of the 2015-2019 market (was that normal? I can’t remember what normal looks like!).


So – that’s the next instalment in understanding the ongoing puzzle that is the current market. Time to be on the sidelines? Absolutely not. You can afford to cherrypick for the first time in a long time, in this market. Guard your powder, don’t be a motivated buyer (NEVER be a motivated buyer), and choose wisely. Fortune will favour the brave, because if it does turn out to be treacle, then when we are finally out the other side it will not be easier to find deals to do – it will be harder. Inflation will also have taken its toll on your capital.


Blackstone limits withdrawals

Some more noteworthy news from the week to comment on – Blackstone limited withdrawals in their REIT, which is a sign that many redemptions are coming as people already see the writing on the wall with forecasts of the US market dropping up to 20% from its peak. The market has more heat with a 40% rise since the beginning of the pandemic, and higher rates with more meteoric rises than the UK this year – however, bond yields are calming down as they are down 70 basis points in the past month (on the important 30 year bond yield in the US) – compared to only 20 basis points off the 5 year gilt yield in the UK in the past month. 


Retail to resi – to save the day? And Welsh “progress”

John Lewis is building 1000 units at £500k per unit, it thinks – all London based, as I understand it. Not sure that will do much to solve any housing crises, but let’s see. Wales saw its proposals become reality – following the Scottish prescribed Private Rental Tenancy introduced in December 2017, there is now an “occupation contract”. The big change is 6 months notice to end a contract from the landlord side. Wonder if many will be sued for breach of contract when not paying rent – that would seem to be the implication of a contract, let’s face it – but unsurprisingly, this isn’t covered it seems. There’s been a spectacular avoidance of non-payment of rent, pretending that this doesn’t happen or isn’t a problem worth addressing. More hostility and less flexibility to landlords will lower stock, and push rents up – yet more. Insanity.


That’s us pretty much up to speed for this week – one of the lesser ones for huge, impactful news – and I, for one, am very grateful for that change! We warm up with inflation figures and interest rate decisions to come over the next couple of weeks – don’t put an interest rate cut on your Christmas list just yet, none of us have been that good, it seems……..keep calm, and carry on!